Detroit's Health Care and Pension Costs: Who Pays the Bill?

August 16, 2013

Detroit's case may be extreme, but its bankruptcy highlights a long-term problem faced by many American cities and states: how to fund generous pension and health care promises that are no longer affordable. The problem has been decades in the making. It has always been easier for politicians to promise generous retirement benefits to public servants than to raise their wages. The bill for today falls due immediately; the bill for tomorrow can be delayed for decades, say The Economist.

The same mindset once caused Detroit's big three carmakers to strike deals with workers whereby they could retire as young as 48 years old with gold-plated pension and health care packages.

In the short term, this bought industrial peace.

In the long term, it bankrupted GM and Chrysler; in 2009 the federal government had to rescue them.

Now Detroit, like other cities, faces a choice. It has made promises to creditors and retirees that it cannot meet in full. How should it share the pain?

The question will be settled in court. The outcome will send ripples far and wide, affecting the holders of municipal bonds, the insurers that guarantee such bonds, state and municipal public-sector workers and, last but not least, taxpayers around America.

First, unlike health care, the city has put aside specific funds to meet very specific pension promises. (A promise of health insurance can be made cheaper in all sorts of ways, but a promise of $30,000 a year can be made cheaper only by breaking it.)

And second, courts have made such pension promises legally very hard to break.

The issue also illustrates an emerging divide in American society. Most public-sector workers can expect a pension linked to their final salary. Only 20 percent of private-sector workers benefit from such a promise. Companies have almost entirely stopped offering such benefits because they have proved too expensive. In the public sector, however, the full cost of final-salary pensions has been disguised by iffy accounting.

The underlying economics of pension funds have deteriorated over the past 40 years. Americans are living longer. A 65-year-old woman can expect to live three years longer than her counterpart could in 1970; a 65-year-old man, four years longer. As the baby boom generation (those born between 1946 and 1964) retires, fewer workers must support more pensioners.